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Stress testing and its Cold War genesis

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From time to time, I came across the name Herman Kahn.  He was  mentioned in papers on stress testing or scenario planning.  Both of these are important tools in risk management for financial institutions.  My Google search of Herman Kahn uncovered a number of accounts.  The best and most entertaining piece on the man is by Menand in a piece for the New Yorker.   Kahn worked at RAND  formulating strategies and policies for countering the nuclear threat from the Soviet Union.    Kahn was known as “the heavyweight of the Megadeath Intellectuals”.  The term “Megadeath Intellectuals” comes from the fact that this group of scientists or strategist were at the forefront of considering the scenarios where the US and the USSR are tipped into all out nuclear war.  Here the cost can range from one or two million to hundreds of millions of lives lost depending on how the scenario plays out.
There are some parallels in stress testing for financial services.  The most value in these exercises comes from understanding how management can respond, what level of risk can be tolerated etc.  However financial services don’t need to deal with an adversary who is “bright, knowledgeable and malevolent”.  At most banks need to think about how they handle a market that suddenly refuses to provide the capital or liquidity they need.  In Kahn’s world, Game Theory was critical, while for financial institutions, the markets and the economy are usually a given.

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